China’s long march to net zero
Salman Siddiqui, Investment Manager, discusses how emerging markets are coping with a challenging global economic backdrop, and points to reasons why the second half of the year could see a turnaround for China.
Historically, it feels like there has always been an assumption that a difficult global economic backdrop would translate into a really tough environment for emerging markets (EM). At various times in the past that would have been a fair assessment, but emerging markets have matured as an asset class and in our view such an assumption would be quite lazy thinking these days.
A lot has changed within EM over the last 10 years. Thinking back to the period of the ‘Taper Tantrum’ in 2013, for example, emerging markets did indeed struggle, especially in currency markets, as countries with high current account deficits came under pressure. During this period India, Indonesia, Brazil, South Africa and Turkey became known as the ‘Fragile 5’. If we look at those economies today, however, we can see that the first four of them have brought their current account deficits right down or even gone into surplus.
Such underlying improvement is reflective of EM as a whole, as countries have undergone structural reform and generally been more responsible in terms of monetary policy (more so than some developed markets, ironically). The result is that a lot of EM currencies have been holding up pretty well in foreign exchange markets this year versus the dollar. Better than the Euro or indeed the pound. In many cases they’ve also been ahead of the game on inflation, having brought in tighter monetary policies last year while most developed market central banks continued to loosen. Remarkably, this is the first time in 20 years that there are fewer EM countries with inflation over 5%+ than developed market countries. So perhaps it’s about time for the old fashioned view of EM to change.
This isn’t to say, of course, that everything in emerging markets is plain sailing right now. In particular, China’s economic growth story has faced three troublesome plot twists: increased regulation of the private sector (especially internet companies), a downturn in the property market, and the ‘zero Covid’ strategy. Regarding these, we think the regulatory tightening is drawing to conclusion, and in many cases is bringing China closer to international standards anyway. The property market does remain an underlying problem, but there are signs that the government is loosening its controls and mortgage rates are coming down – this gives us confidence that China could be past the worst. Lastly, on Covid, there is much speculation on if/when China will let go of its ‘zero Covid’ policy. But there have been encouraging developments here too, with travellers arriving in China now having to quarantine for 10 days instead of 21.
It is also notable that the government is sticking to its 5.5% economic growth target for this year. For context, China’s economy grew below 5% in Q1 this year, while in Q2 when there were a lot of lockdowns growth may be closer to 1%. In order to hit 5.5% for the whole year, therefore, the second half will need to see growth more like 7%-8%, suggesting a likelihood of fiscal or monetary stimulus. That could create an interesting dynamic, as China may start to emerge from its economic funk at just the time when major developed markets could be in the teeth of recession with inflation still high. In that environment we believe Chinese equities should perform well.
It is important to remember that when investing in emerging and developing markets, there is a potential for decrease in market liquidity, which may mean that it is not easy to buy or sell securities. There may also be difficulties in dealing and settlement, and custody problems could arise. Less developed countries may face more political, economic or structural challenges than developed countries. The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
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